India -- a slow burner

India now has the world’s fastest-growing large economy, and the prospects for continued development may well be very good, writes John West.

Great diversity and potential

India has never managed to achieve three decades of 10% annual economic growth rates like China has. But in all its long history India has never had a centralised, authoritarian regime like China has had for over two thousand years, which could provide strong political leadership. India is an immensely diverse country, which is essentially a creation of the British Raj and the Indian railway system that it built. “No one person could change a country with 320 languages”, once said Singapore’s Lee Kuan Yew. This diversity makes governance in India more complex than in China. But India has averaged a very respectable 6 ½ % growth rate over the past 25 years, and the prospects for continued development may well be very good.

India is indeed a country with a great deal of potential. For example, Indians who have migrated to the US, and their descendants, earn on average $88,000 a year, compared with $66,000 for all Asian Americans, and $50,000 for Americans overall. Indian companies like Infosys, Mahindra, Mittal, Reliance, and Tata succeed famously on world markets. The Indian movie industry produces more films than any other country. And the Indian Premier League is the world's most lucrative and popular cricket tournament.

And yet, the Indian economy was for many years a chronic underperformer. During India’s first four decades of independence, the economy chugged along at the “Hindu rate of growth” of about 3.5% (or 1.3% in per capita terms) from the 1950s to the 1980s. Despite a vibrant democracy, India's economic policies drew more inspiration from the socialism of the USSR than the capitalism of East Asia or the West. This was typical of many countries at the time, which sought to achieve economic independence through inward-looking policies, once they had achieved political independence.

Financial crisis triggers reforms

A financial crisis in the early 1990s triggered a wave of economic liberalization and reform. During the following 25 years, the Indian economy has averaged 6 ½ % annual growth, and is currently the world’s fastest growing large economy with growth of around 7 ½ %. India’s GDP per capita more than tripled over this period, with the information technology sector playing a leading role. Thanks to these positive developments, the share of the population living in extreme poverty (less than $1.90 a day) has more than halved over the past decade to around 20%. Despite this impressive achievement, almost 40% of the Indian population is caught between $1.90 and $3.10 a day in a situation of near poverty.

India has suffered from rising inequality like most Asian countries. This has tempted Jean Drèze and Amartya Sen to observe that India looks "more and more like islands of California in a sea of sub-Saharan Africa”. And it is true that beyond the glitter of high-tech Bangalore, Bollywood and Indian cricket, India remains a rural country, with two-thirds of its population living in the countryside. But it is also undeniable that India has made immense progress. As someone who has visited the country in 1975, 1992 and 2014, I must say that India’s progress is palpable.

Ascent of Prime Minister Modi

In the 2014 national elections, the deeply corrupt and incompetent National Congress Party, the party of Nehru and Indira Gandhi, was soundly beaten by the Bharatiya Janata Party (BJP), under the leadership of Narendra Modi. This was the world’s biggest exercise in electoral democracy, and was widely applauded for its transparent, impartial and correct implementation. What’s more, the transition of power from one party to the other went very smoothly. Indian governance may have its problems, notably widespread corruption, but its elections do work well. India’s politics may seem chaotic compared with China’s. But over the longer term, China’s institutions may be more brittle and fragile, relying as they do on repression, censorship and propaganda.

Prime Minister Narendra Modi has been now leading the country for almost three years. He promises so much, based on his successful pro-business leadership as Chief Minister of Gujarat state for over a decade. But despite the impressive earlier reform efforts, Modi has his work cut of for him in many respects.

India would be a very difficult country in which to do business, according to the World Bank which ranks it 130th out 189 countries surveyed. The OECD judges Indian policies to not be “competition friendly”, however it does note a positive trend for barriers to entrepreneurship, and trade and investment. There was another positive trend in the World Economic Forum’s Global Competitiveness Report where, after five years of decline, India jumped 16 ranks to 55th place (out of 140) thanks "to the momentum initiated by the election of Narendra Modi, whose pro-business, pro-growth, and anti-corruption stance has improved the business community’s sentiment toward the government". However, corruption remains a serious problem, which business leaders consider the biggest problem for doing business in India.

India's human capital development is also hampered by one of the very worst education systems in Asia. By some estimates, half of the Indian population would be functionally illiterate. Even at the elite level, not one Indian university figures in the world top 200. India spends next to nothing on public health. Improving human capital will be critical for taking advantage of the half a billion young Indians who will enter the labor force over the next decade. Social discrimination is also rife in India, with a long list of victims like lower castes, religious minorities like Muslims and Christians, indigenous and tribal groups, and women.

Prospects for industrialisation

A major element that has been lacking in India compared with East Asia has been the development of a strong manufacturing sector. India's manufacturing sector has been stuck at around 15% of GDP. The services sector, especially business process outsourcing and tourism, has been a key driver of the economy.

The East Asian model of urbanisation and industrialisation can be very effective for countries with large pools of lower-skilled labour. The model involves a structural transformation of the economy as low-productivity rural labour moves to urban areas to work in export-oriented factories. Today, industrialisation could play an important role in India’s development, since it faces the challenge of creating jobs for masses of semi-skilled young people entering the labour market, and transforming this demographic bulge into a dividend.

Fortunately, Prime Minister Narendra Modi’s government is making efforts to develop its manufacturing sector. Major investments are being made in improving the country’s logistics in areas like coastal shipping, highways, and railways, which would help move products around. Inspired by the government’s “Look East” policy, these efforts are being concentrated on the eastern side of the country, which is close to fast-growing Bangladesh and Southeast Asia. Special economic zones and economic corridors are also being developed.

The timing is right for India to become an industrial power, as China is now suffering from increasing wages, and investors like Japan are looking for new low-cost locations. This is where Prime Minister Modi's business-friendly policies are helpful. For example, the government has liberalised some policies for foreign direct investment (FDI), including through a “Make in India” initiative, and net flows of FDI surged to $32 billion in 2015, nearly 26% higher than in the previous year. Leading companies like Foxconn, Softbank and Microsoft all have plans to invest in India. Korean companies in particular are very successful in India.

Overall, there are strong grounds to be optimistic about India’s future. A lot remains to be done. But India’s economic performance should continue to improve, even if not at the pace of East Asia.